There is an optimal tick size, and regulators should enforce
it. That is the conclusion of a report by broker CA Cheuvreux, 'Navigating Liquidity 6 – a global menu for optimal trading'.

Tick size is the minimal increment between the prices of two
limit price orders. In the US, the tick size applies to all stocks. In the UK,
it depends on the price range and the quotation group that the stock belongs to
– a system called tick size regime on the basis that it is intended to group
stocks according to their liquidity.

The optimal tick size depends on the liquidity of a stock,
with higher tick sizes for less liquid stocks – its price, with higher tick
sizes at higher prices, and its volatility, which is matched by higher tick
sizes as it increases.

The report criticises the US model, on the basis that it is
in effect a “one size fits none” policy that puts a strong constraint on stocks
priced below US$10 and leaves stocks priced above US$200 with “nearly empty
order books that have less meaningful quotes”. CA Cheuvreux suggests that US firms
aware of the impact of tick size on trading are essentially forced to use
splits or reverse splits to reach a satisfactory tick size, but that other
complications such as trading fees based on the number of shares exchanged, often make the choice more difficult.

Europe fares little better, according to the research,
which castigates the ‘gentlemen’s agreement’ that fixed Europe’s tick sizes in
2009 for preventing markets making any changes in tick size in search of
greater efficiency. That agreement followed a tick size war between Europe’s
exchanges, which, barring a brief but unsuccessful attempt by NYSE Euronext,
has resulted in an uneasy return to the status quo ever since.

“Our hope is that the regulator decides to enforce rules on
the subject and does not leave it to market forces,” states the CA Cheuvreux
research. It also insists that the tick size should not be set as low as
possible, since a larger gap between tick sizes helps concentrate liquidity and
creates market depth.